May 7, 2020

The Role of Cash in Retirement

Rule 101 of retirement planning is to ensure you keep a cash reserve (sometimes called an emergency fund) to cover those infrequent and unexpected expenses.  This is true of financial planning at all life stages, but particularly important when you are planning to retire.

This blog looks at why cash is so important in retirement and how to work out how much cash to keep vs how much to invest.

Before we dive in, here are the three golden rules to remember.

  1. Always keep an emergency fund that is at least 2 years’ worth of income needs on deposit.
  2. Never invest cash that you may need in the next 5 years – markets can be cruel in the short term.
  3. Never hold more than £85,000 in one bank as the surplus is not covered by the FSCS protection.


Cash vs Investing

When it comes to retirement income, it is natural to want to take as little risk as possible to generate the income required for your ideal lifestyle.  For many, the only way to achieve their desired lifestyle is to invest a portion of their liquid assets to generate a rate of return greater than inflation.

Working how much to invest vs how much to leave in cash is a fine balance between risk, return, liquidity, and volatility.  There is not a one size fits all solution and everyone has a different financial or psychological capacity to take risk.

The amount of cash reserves you need depends entirely on your circumstances.  As a starter, here are some basic cash principles you can follow as you head into retirement.


Understanding Expenditure

Understand exactly what you will spend (fixed and variable) and keep at least 2 and no more than 3 years’ worth of cash in a readily accessible savings account, earning as much interest as possible.  If the financial or psychological need arises whereby you wish to ‘switch off’ your income from investments and rely on cash, this reserve can be accessed to see you through.

This also acts as an emergency fund (Golden Rule No 1).


The first few years

Consider keeping the first 3-5 years of your income requirement in cash. For example, if you have £2,000/month of guaranteed income from Final Salary Pensions or Rental Income and require a further £2,000/month to fund your lifestyle, you need to keep £120,000 in cash (£2,000 x 60 months). This would give you the income you need for the first 5 years.

Remember Golden Rule No 3 – If this equates to more than £85,000, you need to spread this around to ensure you are fully protected by the FSCS. For help finding the right account try using a cash platform service that can do this for you.  This Which Guide compares some of the most popular options available in the UK.


Big-ticket items

Look forward 5 years and consider any capital expenses that are likely to be required.

Popular examples include.

  • Buying a holiday home or second home
  • Taking the family on holiday
  • Traveling the world
  • Funding weddings for children or grandchildren
  • Funding house deposits for children or grandchildren
  • Divorce (just kidding…sort of)

Tip; Use term-based deposits with longer lock-in periods wherever possible to ensure the highest interest rates.  If you know when the money is required, a tie in period is not necessarily an issue.



Have one-eye on any potential windfalls that may be coming your way such as liquidation of a second property, inheritance, or sale of a business.  This could have a significant impact on the amount of cash you need to save.

Word of warning here, we prefer to ignore this when making assumptions and only factor this in when the money is in the bank!  Better to be cautious in early retirement with too much cash than be left short.  You can always invest the surplus later.


The taxman

One final consideration is the tax implication of cash savings.  Although interest rates are relatively low, holding substantial cash reserves can mean that you are earning a decent amount of interest overall.  For 20% taxpayers the first £1000 of interest is tax-free and for higher rate taxpayers this allowance is reduced to £500. Any interest earned above this is taxed at your marginal rate.

Do what you can to split the cash between your members of the household to ensure you minimize the tax as much as possible.

Tip; Use cash ISA’s wherever possible as any interest is tax-free within an ISA.

Cash is a big part of your retirement income plan.  Too little and you may need to compromise in the short term. Too much and inflation could be eroding your future spending power!

Speak to your financial adviser if you want to ensure you have the right balance or your circumstances have changed.